Treece: Why QE3 is destined for failure

In the minutes from the Federal Reserve Board meeting on Tuesday, we learned that, against the will of many FRB members, the Fed is considering more quantitative easing. We have written and commented before on why this policy just does not work, and we stand by that statement. This will be the third round of QE that has been imposed since the financial crisis of 2008 over the course of two separate administrations, yet we still have yet to see a significant economic recovery. In our opinion, QE policies have been one of a myriad reasons why the economy has yet to turn around significantly.

Quantitative easing is defined as increasing the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity. This can be done in several ways, whether it is putting money straight into the pockets of citizens as President Bush did in 2008, or by printing money and funneling it to lending institutions through either loan programs or the purchase of securities from those institutions as President Obama did in 2010. Either way, the idea is to supply the market with capital that can be spent on projects or consumer goods. What some economists and many politicians fail to realize is that there are more downsides to quantitative easing than good.

If QE were the end-all answer, we would not be seeing the measly 1 percent to 3 percent gross domestic product growth that we have been seeing since 2010. We should be seeing Reagan-era 7 percent to 10 percent growth, but the current administration simply cannot get a grasp on this haltered economy. The fact is that QE will provide a brief jolt to the economy, but nothing that will sustain or be substantial to growth. Imagine that I gave you $100 today; does that mean that you’re going to spend $100 every month for the next year? That is the basic logic behind QE: More money in your pocket today GUARANTEES sustained long-term spending. This is clearly not a logical statement.

Another downside of QE is that it can lead to inflation. More currency in the economy means a less valuable dollar, it is truly that simple. Many figureheads will have you think that monetary policy is much more complex than that simple description. In reality their explanations are all smoke and mirrors. A common argument is that QE does not lead to inflation since we have seen no substantial impact on the U.S. dollar’s value since QE2. However, as Dock David pointed out in “Ingredients for Inflation,”M3 (money supply) has actually been decreasing and inflation has not been realized due to the lack of velocity (money turning over in the economy). This cash is literally sitting at lending institutions waiting to be loaned out in a market where nobody is borrowing.

One question that nobody seems to ask regarding QE is where the money comes from? The easy answer is from the government, but let’s think about this realistically. How can a federal government that currently has no budget in place and is running massive deficits afford to supply more capital to the markets? As we mentioned before, one way could be through the printing of new currency, but this could lead to an inflated dollar, which would be catastrophic for a recovering economy. Another way is through spending by increasing government revenue … also known as hiking taxes. The final way is through debt financing, or the selling of government bonds. These three options for obtaining capital would all ultimately result in economic hardship.

If the Treasury prints new money, we will eventually face drastic inflation if economic growth does not keep up. This will hurt consumers’ pocketbooks and result in a decrease in discretionary spending. The current administration cannot in any way justify hiking taxes, even on corporations and high earners. These are the people who are able to hire and who are out spending money and driving the economy while the rest of America tightens up their finances. Having them pay their “fair share” would result in more jobs lost due to decreasing corporate after-tax revenues and thus fewer dollars to spend for both top earners and Main Street employees who will have lost their jobs due to downsizing. Lastly, the federal government cannot possibly consider financing this venture through debt for many reasons. First of all, nobody in their right mind wants to buy bonds with interest rates as low as they are right now. Secondly, the current administration is already taking flak for its willingness to run up a massive deficit. Borrowing more money (likely from sources abroad) would not sit well with most Americans, something the administration is keeping in mind going in to an election year.

The answer is a simple one that I wrote about in my article “Economics 101: Common Sense” — we must cut taxes. Cutting taxes across the board would result in more money available for households to pay down debt and for discretionary spending while simultaneously allowing for corporations to hire new employees without the fear of hurting their bottom line. It truly is a simple answer, but instead of putting full faith in a tried and tested method, the Fed has shown that they are willing to engage in a policy which has failed twice over now. This is the definition of insanity; repeating the same action over and over and expecting to yield different results.

Ben Treece is a 2009 graduate from the University of Miami (Fla.) with a bachelor of business administration degree in international finance and marketing. He is a partner with Treece Investment Advisory Corp (www.TreeceInvestments.com) and a stockbroker licensed with FINRA, working for Treece Financial Services Corp. The above information is the express opinion of Ben Treece and should not be construed as investment advice or used without outside verification.

Just Blowing Smoke: Taxes by the numbers

As the fall elections approach, ending the “Bush Tax Cuts” is becoming a subject for increasing political discussion. Certainly, no one wants to pay any more than their fair share in taxes, or more that they have to. There seems to be some disagreement over what constitutes enough however, and whether some those who earn the most are paying enough. Cullen Hightower probably put it best when he said, “There’s always somebody who is paid too much, and taxed too little — and it’s always somebody else.”

Treasury Secretary Timothy Geithner, a man who has had his own problems with paying taxes over the years, certainly sees no problem with high earners paying more however. In interviews on most of the major networks last weekend, Secretary Geithner touted the end of the cuts. According to his interview on ABC’s This Week, “We think that’s the responsible thing to do because we need to make sure we can show the world that they’re willing as a country now to start to make some progress bringing down our long — our long-term deficits.” According to his interview on NBC’s Meet the Press, “I do not believe it will have a negative effect on growth”.

Setting aside the intelligence of such statements and economic philosophy for a moment, its apparent that Mr. Geithner has no problem using high earners to help the government balance its budget. The President meanwhile consistently maintains that his goal is to retain tax cuts for 95% of the American people. This curious number is one that organizations looking at taxes have been closely following for years.

According to both the National Taxpayers Union and the Tax Foundation, the 2007 tax information (the last numbers available) show the following:

The top 1% of incomes in the US currently pay 40.42% of the nation’s tax burden.

The top 5% of incomes (those that the Administration feels can accept more of the burden next year) already pay 60.63% of the taxes in this country.

Meanwhile, the bottom 50% of wage earners in this country pay only 2.89% of the taxes on which this country operates.

Now some would say that such numbers indicate that the top 5% are already doing more than their part, but there’s more to these numbers than meets the eye. It should likewise be noted that most small businesses are “S” Corporations and that their profits are treated and taxed as the personal income of their owners. That means that the tax cut expirations will negatively impact many of the very people that have the best chance to have a positive effect on both employment and economic growth in this country. Higher taxes on them would mean less money to invest in building expansion, new equipment, and increased staff.

But wait, there’s more! Ending these ‘cuts’ will also raise the tax on capital gains from 15% to 20%, something guaranteed to discourage investors with any money from putting it back into the market. This lack of investment, beside stalling any recovery, will virtually assure that the money lost by 401k’s in 2008 will never be recovered.

If these two impediments were not enough to contaminate the numbers however, consider this. These changes would also re-establish the estate tax, taking its tax rate from 0% to 55% for everything over $2 million for families. While family farms have often been mentioned as targeted for destruction by this law, certainly many other small family-owned businesses would be forced to dissolve or go into horrendous debt if faced with such an onerous tax rate.

Support for penalizing the wealthiest 5% is not universal however. Ben Bernanke, chairman of the Federal Reserve seems to support retention of the cuts, along with spending cuts. As reported in Bloomberg.com Bernanke Says Tax-Cut Extension Maintains Stimulus “In the longer term, I think we need to be taking steps to reassure the American people and the markets that our fiscal situation is going to be well controlled. That means that if you extend the tax cuts, you need to find other ways to offset them.” Translated, this means that perhaps with debt that’s gotten out of control, Congress and the President might consider instead ending its insult to drunken sailors by discontinuing a level of government spending that even these intoxicated voyagers consider fiscally irresponsible.

Even for the mathematically challenged among us, it’s becoming apparent the numbers no longer work. Government taking money away from people is never an answer to economic recovery and it’s time to say so. Moreover, with its creditors and citizens equally concerned over mounting debt, It’s time to tell Congress and the President that trying to run the country by these numbers simply no longer adds up.

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on Tuesday, July 27th, 2010 at 10:51 am and is filed under Just Blowing Smoke, Opinion.
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